For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

The world’s first index mutual fund for individual investors, now called the Vanguard 500 Index Fund, got a frosty reception when it was launched on August 31, 1976. Initially, it was a hard sell: The fund raised a disappointing $11.4 million in assets at its public offering.

The lack of enthusiasm was understandable. Vanguard wasn’t just introducing a new fund; we were proposing a different way of investing—until then, active management had been the only game in town. And the pitch for indexing wasn’t outperformance; it was to help investors minimize the cost of investing in a broad sense. If you think about it, not being broadly diversified has a cost, portfolio turnover generates transaction and tax costs, and, of course, active management advisory fees are a cost. Indexing hits at those headwinds straight on. That’s helped it evolve from a derided experiment to the default investment approach for many investors and retirement programs. According to Strategic Insight, index strategies accounted for about 34% of mutual fund and exchange-traded fund assets at the end of 2015—an astounding shift from zero to about $3.47 trillion in assets in just 40 years.

It’s obviously not dinnertime conversation in a lot of households, but there have been plenty of innovations in indexing since 1976, and Vanguard has influenced a good number of them. For many years, Vanguard has brought methodology improvement ideas to the table in regular discussions with the major index providers. For instance, to improve investability, we pushed for indexes to reflect the free float of a company, as opposed to just shares outstanding. We’ve also partnered with index providers on setting capitalization cutoffs between large-, medium-, and small-cap stocks, smoothing stock transitions between those categories when indexes rebalance, and coming up with more robust criteria for identifying growth and value stocks. That’s been a win-win for the index providers and our clients, as these methodology improvements have helped indexes become more investable and behaviorally more similar to how you would want a long-term, diligent investor to manage a well-diversified pool of assets.

We’ve also found opportunities over the years to improve how we manage our index funds here at Vanguard. Continuing to lower costs is an important aim because it improves an investor’s net return. Some explicit costs, such as commissions and custody costs, have come down, as rising assets under management have created increasing economies of scale for our funds. Indexers also face implicit costs associated with the potential impact of executing trades in the market. Developing techniques and strategies to minimize these transaction costs has been a hallmark of Vanguard’s index management approach, allowing investors to keep more of their returns.

Probably the biggest change indexing has brought to investing is that it’s opened everyone’s eyes to the importance of costs. Investors have clearly gotten the message given the phenomenal cash flows into index funds, which are possibly the purest form of low-cost investing. Many active managers have as well. With index funds as inexpensive options for capturing the market return, the bar has risen for managers to produce investment performance in excess of the market return after fees—a feat that has proven difficult over multi-year periods. In that sense, the advent of indexing helped to bring down investment costs across the entire mutual fund industry, a win for both index and active investors.

Notes:

Diversification does not ensure a profit or protect against a loss.

All investing is subject to risk, including the possible loss of the money you invest.

Joe Brennan

Joe Brennan leads the Vanguard Global Equity Index Group. He previously served as our Australia-based Asia Pacific chief investment officer. Previously, Joe was head of the Vanguard Portfolio Review Department with responsibility for oversight of more than 160 mutual funds and monitoring of external investment advisors. He joined Vanguard in 1991. Joe earned a B.A. in economics from Fairfield University and an M.S. in finance from Drexel University. He is a CFA® charterholder and a member of the CFA Society of Philadelphia.

Comments

Richard G. | September 3, 2016 12:57 pm

To Mr. Brennan:I had to blog again regarding this indexing thing.In several of Mr. Bogle’s books he mentions this term “closet indexers”.I would love to see an expose about how many “Wall street brokers” are indeed indexers with their own portfolios.They have to know that they are not going to make any money when they have to pay those enormous loads that they charge their clients to open their accounts.I bet this would be an eye opening report.I personally do not have a lot of respect for any of them as they do not maintain a feduciary relationship with their clients. They have shown me that they are only interested in using their clients as a financial mule to make them money.There was a story that I read about a broker showing a prospective client around the local boat harbor.The broker was pointing out all of the bankers.brokers and CEO’s yachts.The customer then asked the broker “Where are your clients yachts? Where indeed! Lets get our 4th Trillion in 2016!

Ismaila B. | September 3, 2016 12:17 pm

I have been with fedelity for so many years but gained very little from my investment. Now that I moved to vanguard I am gaining my investment worth. I have few years more to retirement. Thanks to vanguard team. For taking care off my investment worth for me.

Richard G. | August 31, 2016 1:48 pm

To Mr. Brennan: Another great article that is very on point. I am a newbie to Vanguard and while I accumulated my wealth through the federal government employee benefits offered I was also emulating what Vanguard teaches.I started early and I put in the maximum 15% into the offered TSP 401k program.I bought the whole market which at the time consisted of five funds.As you know our fees for the federal government were very low so I was blessed for this.As far as I am concerned Mr. Bogle has created the “eighth wonder of the world”.He has allowed the “little guy” to invest just like the big boys.After over 44years of saving my ducats I do not consider myself to be a little guy any longer.In 2010 I retired and Trustee to trustee transferred my life”s savings to Vanguard. I read extensively about financial stuff and I have read and purchased three of Mr. Bogle’s books.I know he took a lot of ridicule from so called experts in the industry at the time for starting Vanguard’s index fund.He is a giant of the industry and showed a tremendous amount of backbone and old fashion “guts” in starting something that was unheard of up to that time.There is no doubt in my mind that I am going to become a millionaire thanks to Vanguard.I am so ready to help our company reach our 4th Trillion in 2016!Please keep up your great articles. Your client/owners thank you all for keeping Vanguard as the #1 investment firm in the world.Lets go get it!

Pankaj P. | August 31, 2016 10:38 am

Don N. | August 31, 2016 10:26 am

Clearly, investors have become more knowledgeable about costs and the superior performance of many basic index funds over actively managed funds, but as more investors vote with their feet and pile into index funds mimicking the entire stock market or the S &P 500, the buyers overwhelm the sellers and the index funds go up and that attracts more investors and the cycle is repeated. Eventually, it would seem that everyone would be buying the “stock market,” except a small minority of hard line investors who still think they can beat the market. Can this trend continue forever? Are we headed toward an “index fund bubble?”

J C. | August 31, 2016 1:17 pm

Ive been a Vanguard index investor since 79. I share you’re concern for what you mention. I wonder if when so many boomers begin to sell shares for income if this will permanently depress share prices. I would like to see a blog address that.

Michael G. | August 31, 2016 9:21 am

Low cost index investing has made setting up an overall balanced portfolio a fairly simple task for the average investor today. My thanks to John Bogle for being the pioneer of low cost investing and diversification for us all. We all owe Bogle our thanks for having the guts to be a leader in the industry years ahead of all of the others.

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.